WPX Energy reported several positive developments in the second quarter, including a revised assessment of its drilling inventory in the Delaware Basin. This was partly attributed to the recognition of new locations in benches and intervals previously considered too speculative to include. Additionally, management now expects tighter spacing of its future wells than before and recoveries are projected to be higher than before as well.

The firm also bolstered its Delaware inventory by purchasing 7,800 net acres of additional acreage in Eddy County (New Mexico) in July. The purchase includes 425 barrels of oil equivalent per day of current production (55% oil). While management did not disclose the price paid, we note that Diamondback Energy recently made an acquisition in that area for around $29,000 per acre. That would imply a price tag of $230 million, which is consistent with management commentary that its pro forma liquidity is $1.6 billion (translating to $1 billion cash and $1 billion available on its revolver, less $160 million maturing debt). The firm reports 5,500 net drilling locations currently in its Delaware Basin inventory, above our previous estimate of 3,620.

While this additional inventory is accretive to our valuation, we have also raised our weighted average cost of capital for WPX to 10.4% from 9%, based on the high cyclical risk to equity that stems from the firm's high leverage. As such, our fair value estimate has moved to $2 per share, substantially below the current stock price. But while the firm has ample liquidity, we argue that its high leverage will prevent it from growing as quickly as the market expects. Specially, we project $330 million of EBITDA in 2017 (below consensus' $513 million). Therefore, while the market enterprise value of $5.1 billion implies a lofty (consensus) EBITDA multiple of 9.9 times, our own enterprise value estimate of $2.4 billion is consistent with a more reasonable (Morningstar) EBITDA multiple of 7.4 times.

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